Private Mortgage Investing, What you need to know?  Is it for you?

This is a special article published to my blog, written by Dean Larson, COO of Northern Alliance Financial. If you have any questions, please contact me directly.  

Increasingly, Canadians are becoming more and more aware that traditional investments may not be their only or even best options anymore.   The average Canadian, particularly Gen Xers or Millennials, are less likely to blindly follow traditional investment advice from a bank, or even from that family friend, a financial planner, or insurance advisor.

The question is - what has changed?   Have people’s expectations changed?   Have investments changed?   Have our available options changed?   The answer to all of these is a resounding “YES!”   Historically, banks and insurance companies have created investment opportunities.   Consumer-focused investments included life insurance, bonds, mutual funds and other similar products with the object of providing neatly packaged, relatively conservative, accessible investments to the masses.

Today, the public has access to a myriad of investment options that would have once been relegated exclusively to very wealthy individuals or institutional investors.   One of these investment options is mortgage lending.

The mortgage market today can be divided primarily into the following categories:

‘Prime’ or ‘A’ Mortgages – These mortgages are for typical mortgage borrowers with good credit, regular employment and a down payment.   These low-rate mortgages are obtained primarily from banks, credit unions and monoline mortgage lenders (non bank lenders who are specifically in the mortgage business, and often funded by other big banks).

‘Alt A’ or ‘B’ Mortgages –.   These mortgages are designed for borrowers that fall just outside of standard mortgage qualification guidelines.   Some borrowers cannot prove self-employment income in standard ways, or provide non-standard down-payments, or have past credit blemishes. Institutional lenders and banks that are specifically focused on this type of lending typically have higher interest rates than ‘A’ lenders.

Private Mortgages – Private mortgages themselves can be divided up into two categories:

Advantages for an investor to invest through a fund rather than direct to the borrower include:

i) The investor’s money is in a pool with other investors and invested in a pool of mortgages.   So if a mortgage were to default and realize losses, the loss to fund is dispersed among the investors.   Typically a well-managed fund can have defaults without individual investors being aware, or suffering significant impact on their returns.

ii) The investor is not concerned about managing the investment, or regulatory issues.   The investor is not responsible for any reporting to the borrower, or any managing of defaults, or the payout of the mortgage.

Mortgage funds create a great opportunity for an investor to earn consistent above-average returns.   As an investor in a mortgage fund you own shares or units of a Mortgage Investment Corporation (MIC) or Mutual Fund Trust (Trust).   That MIC or Trust holds real mortgages registered on title of the subject property.   It is not uncommon to see returns of 6-10% consistently on these types of funds.   In addition, these investments can often be held within an RRSP, TFSA, RESP, or a variety of other registered investments vehicles, providing the fund has completed the necessary CRA registration.

In spite of all of these positive attributes, not every mortgage fund in Canada has been consistently successful and some have had catastrophic failures.   So how does an investor assess comparative risk from one fund to another?   What does the investor look for in a fund, to allow themselves the opportunity to take advantage of the strong returns, while also matching a conservative to moderate risk tolerance?

Below are some key questions one should ask when assessing a fund.

or

Many funds have been sunk by guaranteeing a return.

The above factors must be considered but there are complexities to ensuring that the criteria make sense in the right scenario. The tight rope of providing a solid return while not overextending risk is a developed skill.   The success of this will boil down to who your fund’s management team, and if they possess the skills and experience to recognize the reactive correlations of the a-e factors listed above.

In Summary, mortgages represent an excellent high yield opportunity for any investor to participate in the real estate and mortgage market, and to obtain returns that will often beat public markets.